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Emissions Trading
Scheme (ETS)

A carbon emissions trading scheme is aimed at reducing total greenhouse gas emissions.

Operators are required to surrender allowances to cover their greenhouse gas emissions. A Carbon emissions trading scheme allows installations to sell any excess allowances that are unused.

If an operator does not have enough allowances to cover their emissions, extra may be bought to ensure that they are not penalised.

The UK ETS was introduced by the UK Government for UK installations post-Brexit. Phase 1 was launched in January 2021. It operates using very similar rules as the EU ETS.

The UK ETS is a ‘cap and trade’ system, aimed with reducing the total greenhouse gas emissions from energy intensive industries. Emissions are converted into tradable allowances, with the capped emissions reducing each year to provide an economic incentive for installations to decarbonise.

Set up in 2005, the EU ETS is the world’s first international emissions trading system. It is a ‘cap and trade’ system where emissions are converted into tradable allowances and the overarching aim is to reduce greenhouse gas emissions by providing financial incentives for participating operators.

The EU ETS It covers over 11,000 installations across the EU, which is equivalent to 45% of EU Emissions.

A UK Emissions Trading Scheme (UK ETS) replaced the UK’s participation in the EU ETS on the 1st January 2021.

The UK ETS was introduced by the UK Government for UK installations, post-Brexit, in January 2021. It operates very similar rules as the EU ETS and there is the possibility that the schemes will be linked in the future. There are some slight differences to the scheme to reflect the UKs commitment to net zero.

To reflect the UKs commitment to net zero the UK ETS shows greater climate ambition.

The UK ETS has a separate market and carbon will be traded as UKAs. The main changes to be implemented in the UK ETS are listed below:

Increased 5% cap

on auctioned emissions

Increased 5% cap

on small emitter targets

A new UK registry

There will be an initial review of the UK ETS in 2023 to assess its performance in Phase 1. This will include a review on free allocation, exploring the possibility of using UK benchmarks and a review of sectors included on the carbon leakage list to ensure that allocation is fair and proportionate.

Any necessary changes highlighted in the review will be implemented by 2026.

As of January 2021, most UK installations are no longer in the EU ETS. They are in the UK ETS, which abides by very similar rules and principles. Electricity Generators within Northern Ireland may still part of EU ETS.

To check whether your business should have an EU ETS or UK ETS permit use our eligibility checker

If a site has a combined stationary combustion thermal capacity of >20 MWth then it may need an ETS permit and be required to monitor and report its emissions under one of the schemes.

For more information visit our UK ETS page

The EU ETS (Emissions Trading system) works as a ‘cap and trade’ system.

Each installation has to surrender carbon allowances to cover their emissions and some installations will received a free allocation of allowances. If an installation emits less tonnes of CO2 than their free allocation, the surplus may be sold. If an installation does not have enough free allowances to cover their emissions, these can be bought on the carbon market.

A Carbon allowance is a tradable licence to emit one tonne of CO2.

Free carbon allowances are allocated based on greenhouse gas performance benchmarks, determined by the most efficient of installations within each industry.

Electricity generators have not received free allowances since 2013 and over the next phase the proportion of free allowances for other sectors will decrease in line with ambitious greenhouse gas reduction targets.

The CCM is a tool that allows the UK ETS Authority to intervene if carbon prices are elevated for an extended period. The CCM will be more reactive in the first few years of the UK ETS due to the unpredictability of a new market. In 2021, the CCM will be triggered if the average allowance price on the secondary futures market is double the average price for the preceding 2-year period, for 3 consecutive months. For example, for the CCM to be triggered in August 2021, the monthly average carbon price will need to remain on average above £45.90 in June, July and August.

If the CCM is triggered the UK Authority could do any of the following:

The free allocation of allowances for each installation is calculated using a sites activity level and greenhouse gas emission benchmarks.

Calculate

The benchmarks are based on product (i.e. tonnes of glass produced), heat consumed within the installation, energy from fuel inputs or process emissions.

Identify

Installations at risk of carbon leakage will receive 100% of their preliminary allocation. Those installations not exposed to carbon leakage will see a phased reduction in allowances.

Review

From 2021 dynamic allocation means that allocation can now be adjusted annually, based on a site’s activity level. Activity level is reported annually and a significant increase or decrease of greater than 15% will impact the allocation.

Notify

To keep track of activity levels, installations will now need to submit verified Annual Activity Level reports by the 31st March each year. This is in addition to the annual emissions report that also has to be submitted by the same date.

Record

The methodology for determining a sites activity level is outlined in the installations MMP (Monitoring methodology plan) which should be approved by the regulator.

All full participants, excluding power generators, are eligible to apply for free allocation. The next opportunity will be in 2024 during the mid-phase re-baselining. Free allocation is based on various benchmarks: product, heat, fuel and process emissions. Allocation can be calculated in the NIMs template.

For eligible new installations, a free allocation can be applied for by submitting a verified activity level report.

An installation/industry is exposed to carbon leakage when there is a risk of transferring production to a country with less stringent climate policies.

Whether an installation is exposed to carbon leakage depends on the NACE or PRODCOM codes that an operator reports against.

An electricity generator is an installation that produces electricity and exports it off site. Only sites that have combustion as their main annex 1 activity are classed as an electricity generator. For example, a site producing bulk organic chemicals can export electricity and still apply for free allocation.

If you are a hospital or, are a low emitter and produce less than 25,000 tCO2 annually or have a total input capacity of less than 35 MW thermal, you may be able to opt out of the main scheme and join one of the small emitter schemes. There are two ETS opt out schemes with different inclusion criteria.

  • Article 27 (Small Emitter and Hospital Opt-out scheme)
  • Article 27a (Ultra small emitter scheme)

ETS opt out scheme – Article 27 (Small Emitter and Hospital Opt-out scheme)

The small emitter scheme has simplified reporting requirements and does not require installations to get their emissions verified. Installations that emit less than 25,000 tCO2 annually or have a total input capacity of less than 35 MW thermal could apply for the scheme. All hospitals that require a GHG permit could also apply for this scheme.

Instead of surrendering allowances, installations are given emissions targets based on an average of their historic emissions. EU ETS Phase 4 and UK ETS targets were set using the average emissions over the baseline period (2016-2018) with an initial reduction factor applied.

If installations emit less than their target, there will be no fee for their emissions and the excess target will roll over to the next year. However, if the target is exceeded, a civil penalty rate will be applied to the tCO2 over the target. See our blog post on civil penalties for more information.

If installations that are not classed as hospitals exceed the 25 000 tCO2 threshold then they will enter the full scheme the following year and their registry accounts will be unfrozen to allow them to access free allocation if they applied for it through the NIMs.

How do small emitter targets work?

If installations emit less than their target, there will be no fee for their emissions and the excess target will roll over to the next year. However, if the target is exceeded, a civil penalty rate will be applied to the tCO2 over the target. See our blog post on civil penalties for more information.

ETS opt out scheme – Article 27a (Ultra small emitter scheme) 

This is a new scheme introduced for the EU ETS Phase 4 and UK ETS.

To be eligible you must emit less than 2500 tCO2 per annum.

Installations are excluded from any formal reporting of emissions to the competent authority unless the threshold is exceeded. 

Operators still need to monitor emissions and if the threshold is exceeded, they either join the Article 27 (small emitters and hospital opt-out scheme) or become full participants – depending on what was specified in the NIMs. 

The chance to opt-out only occurs at the start of a phase during the baseline exercise.

The next opportunity will be during the re-baselining exercise, due to happen in 2024. This allows new installations or sites that have become eligible during the phase to opt-out.

As in EU ETS, operators can apply to enter the small emitter scheme if the installation:

  • emits less than 25,000 tonnes of carbon dioxide equivalent (CO2eq) each scheme year in the relevant period
  • has a total rated thermal input of less than 35 megawatts (MW) in the relevant period (if applicable)
  • is a hospital

MRV stands for monitoring, reporting and verification. These are the requirements of carbon trading schemes.

The cycle runs January to December and applies to both full participants and members of the small emitter and hospital opt out scheme.

During the year, it is expected that Operators are collating data, reviewing site procedures and keeping the competent authority informed of any deviations to their monitoring plan through notifications and permit variations. Emissions must be reported by the 31st March of the following year. Full participants that are eligible for free allowances must also submit their activity level report by the same date. Allowances must the be surrendered by the 30th April. Of the same year.

Verifiers are external, independent bodies that are accredited (UKAS in the UK) to verify annual emissions reports. The verification process is subject to strict external and internal procedures. The verification process normally begins from September through to the final reporting of an operators annual emissions which is submitted through the regulators on line reporting system.

Final verified annual emission reports must be submitted to the Competent Authority for review by 31st March.

Due to dynamic allocation, introduced in January 2021, full participants eligible for free allowances are required to submit a final verified annual activity level report alongside their annual emissions report, by the same date.

To comply with the EU ETS and UK ETS scheme, installations must comply with the conditions of their ETS permit and the GHG Monitoring and Reporting Regulations. This involves updating the competent authority with changes to fuels and equipment on site.

Emissions must be monitored and reported annually, and enough allowances surrendered to cover emissions.

Registry accounts allow operators to trade carbon allowances.

A new UK registry has been set up and UK ETS Operators should now have a Holding Account.

Company details are being transferred over from the EU Registry, however, personal details of the primary contact and nominated authorised representatives are required to be submitted.

The first UK ETS auction took place on the 19 May 2021, held on the Intercontinental Exchange (ICE). The auction calendar can be found at the following link:

https://ir.theice.com/press/news-details/2021/ICE-publishes-auction-calendar-for-UKs-new-Emissions-Trading-Scheme/default.aspx

The UK carbon market works on the same principles as the EU carbon market, on a much smaller scale. Due to the instability of a new market the cost containment mechanism triggers have been set lower to avoid prices getting too high. For more information on carbon pricing and trading, speak to our associates at Redshaw Advisors.

Dynamic allocation is designed to recognise that installations can change substantially within a phase and these changes can impact their requirements for free allocation. It aims to ensure fair distribution of free allowances as the overall level of free allocation decreases over the phase.

The level of an installations free allocation will be adjusted based on a two-year rolling average of activity level. If there is a variation of +/- 15% of the Historical Activity Level (HAL) then the level of allocation will be altered accordingly.

Increase in energy efficiency is encouraged, so if activity levels fall by 15% due to energy efficiency measures, allocations should not be affected.

A sites MMP (monitoring methodology plan) outlines how activity levels are calculated for each reporting year.

It defines which benchmarks are applicable to each installation and, how fuel and energy data is split between each sub-installation.

Installations that have applied for free allocation are required to complete an activity level report annually. Activity level at an installation is calculated according to the MMP and is split into applicable benchmarks.

Activity level reports must be submitted annually due to dynamic allocation which is based on a two-year rolling average. If an installation’s rolling average increases or decreases by >15% compared to their HAL (Historical Activity Level) then their allocation will be adjusted accordingly.

Activity level reports are submitted along with the Annual Emissions Report form on ETSWAP. If installations have not applied for free allowances then Activity Level Reports do not need to be submitted.

Installations in the Small Emitter and Hospital Opt-Out Scheme will not have to complete activity level reports are do not receive an allocation.

A Competent Authority (CA) is the regulator and depends on which UK country your company is based in. In England it is the Environment Agency, in Wales it is Natural Resources Wales, In Scotland it is the Scottish Environment Protection Agency, and in Northern Ireland it is the Department of Agriculture, Environment and Rural Affairs.

The principle of carbon trading in UK ETS is the same as in EU ETS, however, carbon allowances (UKAs) will be traded within their own market and a new UK registry has been set up. In line with the UKs commitment to net zero there is a 5% cap on auctioned emissions.

To avoid very high or low carbon prices on in the UK carbon market there is an auction floor price of £22/tCO2.

To restrict the price increases of Carbon year or year, a Cost Control Mechanism (CCM) is in place which is designed to prevent excessive price increases.

Our associates at Redshaw Advisors can provide more information on carbon trading.

Swan Energy Know How
Swan Energy has been involved with the UK Emissions Trading Scheme (formerly EU ETS) since its inception. We ensure our clients are 100% compliant, relieving hassle and the risk of mistakes and penalties.